What economics can (and can’t) tell us, part 2: Getting the best deals

I don’t know about you but I always dread “that time of the year” when I have to revise all my contracts – home insurance, energy, water, and so on.  I dread it so much that I usually stick to the same provider. It’s lazy, I know – but shopping around used to be so laborious – sending my details over and over again to various companies hoping for a good quote…  So I’m delighted to have finally discovered price comparison websites – it’s made a huge difference. Less effort, and bigger savings – what more can you want?! The websites have helped me get the best deal.

Economics has a lot to say about “best deals” – whether for individuals like me, businesses or entire countries. The framework it uses to analyse deals is “incentives”.

Incentives – how people benefit or lose out from small changes in their or other people’s behaviour – are at the very core of economics. It sounds nerdy, but incentives really do make the world go around. For instance, Paul Collier’s Wars, Guns and Votes outlines how elections and other democratic institutions can create more problems than good if the incentives aren’t right.  Richard Thaler and Cass Sustein’s influential book “nudge” focuses on creating and using small incentives to make big improvements to wellbeing. Sendhil Mullainathan did a videocast talk a couple of years ago applying these “nudge” incentives to climate change action.

Getting the best deal out of a voucher in Haiti to avoid hunger. Photo: DFID, 2010

However, unlike my little annual search for the best insurance, governments are often trying to get the best deals for huge contracts that can last over 30 or 40 years for resources such as oil, copper, water and land – whose value is hard to pin down. In doing so, governments have few companies to negotiate with – the very structure of natural resources means that the companies extracting them have to be large (economists call this an oligopsonistic market structure – this great website explains such structures using supermarkets).

This means that governments have very strong incentives to shop around. But shopping around is only possible if resource prices are out in the open.

Openness is certainly on the rise. The DFID-supported Extractives Industry Transparency Initiative (EITI) encourages private companies and governments in resource-rich countries to reveal the payments and revenues for the resources they’re handling. When visiting Nigeria last month, The UK’s Prime Minister called on the EU to require extractive companies to go further and report such payments wherever they operate (something the US has recently decided to do). The Revenue Watch Institute recently argued that countries should also publish their natural resource contracts, though confidentiality concerns have held them back from doing so in the past. The government of the Democratic Republic of Congo has started to publish its oil and mining contracts. The Ghanaian Energy Ministry has also posted several oil contracts on its website.

Now, the usual interpretation of the impact of such openness measures is that they allow scrutiny by civil society and other stakeholders, reduce the potential for corruption, and thereby better align individual incentives with the country’s incentives. But incentive analysis suggests that openness could do even more.

Like my price comparison website allows me to look at insurance deals in an open and transparent way, publishing existing payments or possibly even contracts for natural resources could allow governments to check which companies offer the best prices, and negotiate to get the best deal, quickly and efficiently. Better deals could mean more revenues for governments to spend on increasing economic growth and reducing poverty.

Perhaps a global mining or oil price comparison website is a bit too far-fetched, but who knows… At the very least, I’m hoping that DFID’s new call for primary research on resource scarcity, growth and poverty reduction will be a good incentive to investigate these issues and solutions more thoroughly. Incentives can and really do change the world!

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